A DIVIDEND is a payment many companies make to shareholders out of their excess earnings.
It's usually expressed as a per-share amount. When you compare companies' dividends,
however, you talk about the "dividend yield," or simply the "yield." That's the dividend amount
divided by the stock price. It tells you what percentage of your purchase price the company will
return to you in dividends. Example: If a stock pays an annual dividend of $2 and is trading at $50
a share, it would have a yield of 4%.

Not all stocks pay dividends, nor should they. If a company is growing quickly and can best
benefit shareholders by reinvesting its earnings in the business, that's what it should do.
Microsoft doesn't pay a dividend, but the company's shareholders aren't complaining. A stock
with no dividend or yield isn't necessarily a loser.

Still, many investors -- particularly those nearing retirement -- like a dividend, both for the income
and the security it provides. If your company's stock price falters, you always have a dividend.
And it is definitely a nice sweetener for a mature stock with steady, but unspectacular growth.

But don't make the mistake of merely searching for stocks with the highest yield -- it can quickly
get you in trouble. Consider the stock we mentioned above with the $2 dividend and the 4% yield.
As it happens, 4% is well above the market average, which is usually below 2%. But that doesn't
mean all is well with the stock. Consider what happens if the company misses an earnings
projection and the price falls overnight from $50 a share to $40. That's a 20% drop in value, but it
actually raises the yield to 5% ($2/$40). Would you want to invest in a stock that just missed
earnings estimates because its yield is now higher? Probably not. Even when searching for
stocks with strong dividends, it's always crucial to make sure the company clears all your other
financial hurdles.

When you're searching for stocks with high dividend yields, one quick check you should always
make is to look at the company's payout ratio. It tells you what percentage of earnings
management is doling out to shareholders in the form of dividends. If the number is above 75%
consider it a red flag -- it might mean the company is failing to reinvest enough of its profits in the
business. A high payout ratio often means the company's earnings are faltering or that it is trying
to entice investors who find little else to get excited about.